Apr. 25, 2013

How Can Hedge Fund Managers Use Advisory Committees to Manage Conflicts of Interest and Mitigate Operational Risks? (Part Two of Two)

Domestic hedge funds typically have no governance analogue to the offshore fund board of directors.  This governance asymmetry has been receiving increased scrutiny from regulators and investors, and that scrutiny has grown stricter in light of a series of notable governance failures.  In response to that scrutiny, hedge fund managers have been exploring, and in some cases implementing, advisory committees for their domestic funds.  At a broad level, advisory committees serve as a proxy board of directors for domestic hedge funds, typically Delaware limited partnerships.  But advisory committees often do more than replicate onshore the functions of an offshore board of directors.  To help hedge fund managers assess the applicability of advisory committees to their circumstances, this article – the second in a two-part series – addresses what types of funds should organize advisory committees; issues involved in organizing an advisory committee (including determining the committee’s composition and compensation); operation of advisory committees; benefits and drawbacks of serving as an advisory committee member; and liability and indemnity protections afforded to advisory committee members.  The first installment discussed what advisory committees are; their principal functions; how they are different from offshore fund boards of directors; how much authority advisory committees typically have; and the principal benefits and drawbacks of organizing and operating advisory committees.  See “How Can Hedge Fund Managers Use Advisory Committees to Manage Conflicts of Interest and Mitigate Operational Risks? (Part One of Two),” Hedge Fund Law Report, Vol. 6, No. 15 (Apr. 11, 2013).

U.S. District Court Conditionally Approves CR Intrinsic Settlement with SEC Despite “Neither Admit Nor Deny Liability” Provision

A hedge fund manager that is negotiating a settlement to terminate an SEC enforcement action should not assume that a U.S. District Court will “rubber-stamp” the proposed settlement.  A recent decision by a U.S. District Court conditionally approving the settlement of the SEC’s civil insider trading action against hedge fund manager CR Intrinsic Investors, LLC shows that even a landmark settlement amount that gives the SEC virtually everything it could have won at trial will not insulate the settlement from close judicial scrutiny when the defendant does not admit any of the SEC’s allegations.  This article summarizes the Court’s decision, which provides an excellent discussion of the policy, legal and practical issues that courts have been considering when asked to approve SEC settlements.

New SEC and CFTC Rules Require Certain Hedge Fund Managers to Establish Policies and Procedures to Combat Identity Theft

On April 10, 2013, the SEC and the U.S. Commodity Futures Trading Commission (CFTC) jointly adopted rules to require certain hedge fund managers and other financial institutions to implement programs designed to detect and address identity theft, which is “fraud committed or attempted using the identifying information of another person without authority.”  More specifically, certain hedge fund managers that are registered or required to be registered with the SEC as investment advisers, as well as certain commodity pool operators and commodity trading advisors (as defined in CFTC regulations) will be subject to the new identity theft rules.  See “CPO Compliance Series: Registration Obligations of Principals and Associated Persons (Part Three of Three),” Hedge Fund Law Report, Vol. 6, No. 6 (Feb. 7, 2013).  SEC Commissioner Luis Aguilar recently observed, “investment advisers registered under the Investment Adviser Act, particularly the private fund and hedge fund advisers that are recent registrants with the SEC, might not have existing identity theft red-flag programs, and will need to pay particular attention to the rules being adopted.”  This article discusses: (1) which hedge fund managers will be subject to the new rules; (2) the required elements of identity theft programs; and (3) some steps that covered entities must take to administer their identity theft programs.

Roundtable Addresses Trends in Hedge Fund Operational Due Diligence, Fund Expenses, Administrator Shadowing, Business Continuity Planning and Cloud Computing

At a recent roundtable, hedge fund investor due diligence experts offered their perspectives on evolving hedge fund manager operations and investor due diligence practices.  The panelists addressed various specific topics, including: the impact of regulations on investor due diligence processes; investor responses to increased insider trading risks; scrutiny of fund expenses; administrator shadowing; business continuity planning for hedge fund managers; and the benefits and risks of cloud computing services.  These investor perspectives can provide useful information for hedge fund managers looking to refine their capital raising efforts.  This article highlights the salient points discussed on each of the foregoing topics.

Infovest21 Survey Reveals Hedge Fund Manager Perspectives on Top Concerns, Business Changes, Staffing, Investor Allocations, Fund Terms, Fees and Portfolio Composition

Infovest21, LLC, which provides information services for the hedge fund industry, recently released a report detailing the findings from a survey of small, medium-sized and large hedge fund managers.  Survey respondents offered their thoughts on recent changes in their businesses; staffing; investor composition; portfolio composition; product composition; popular investment strategies; fund terms; and drivers for investor allocation decisions.  This article highlights the key findings detailed in the report.

GAO Report Dissects the Mechanics of the Political Intelligence Market and Highlights Insider Trading Risks for Hedge Fund Managers

Hedge fund managers and other sophisticated investors are increasingly seeking out political intelligence (as defined below) to inform their investment decision-making.  While political intelligence can give hedge fund managers a trading edge, it also presents insider trading and other legal risks.  See “Former Federal Prosecutors Share Perspectives on Insider Trading Hot-Button Issues and Enforcement Trends Relevant to Hedge Fund Managers,” Hedge Fund Law Report, Vol. 5, No. 39 (Oct. 11, 2012).  To address such insider trading risks, Congress passed the Stop Trading on Congressional Knowledge Act (STOCK Act) in 2012 to clarify that insider trading laws, including Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, apply to information derived from members of Congress and their staffs.  See “Political Intelligence Firms and the STOCK Act: How Hedge Fund Managers Can Avoid Potential Pitfalls,” Hedge Fund Law Report, Vol. 5, No. 14 (Apr. 5, 2012).  The STOCK Act defines political intelligence to include information that is “derived by a person from direct communications with an executive branch employee, a Member of Congress, or an employee of Congress; and provided in exchange for financial compensation to a client who intends, and who is known to intend, to use the information to inform investment decisions.”  As part of the STOCK Act, Congress commissioned the United States Government Accountability Office (GAO) to study the role of political intelligence in investment decision-making and any attendant risks that could require the passage of additional legislation.  The GAO recently published a report detailing its findings (Report).  The Report discusses: (1) what is known about the sale of public and nonpublic political intelligence, including the extent to which investors rely on such information and the effect the sale of political intelligence may have on financial markets; and (2) potential benefits, costs and challenges associated with suggested legislation that would impose disclosure requirements on those who provide, gather, sell or use political intelligence.  The Report offers hedge fund managers a richer understanding of the political intelligence market and the risks involved in using this type of information in their investment decision-making.  This article summarizes key findings of the Report.

Man Group General Counsel Stephen Ross to Join Sidley’s London Funds Group

On April 23, 2013, Sidley Austin LLP announced that funds lawyer Stephen Ross will join the firm as a partner, and will co-head its London Investment Funds group, part of the firm’s global Investment Funds practice.  For analysis from Sidley Austin, see “How Can Hedge Fund Managers Understand Recent SEC Developments to Mitigate Enforcement Risk?,” Hedge Fund Law Report, Vol. 6, No. 8 (Feb. 21, 2013).